Primer Notes

Introduction: What is Corporate Governance?

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War between individual freedom and institutional power

Debate: making corporate power compatible with the needs of a democratic society
Challenge: how to encourage the liberation of individual energy without inflicting unacceptable costs on
individuals and society
Corporate Governance
o CG deals with the systems, rules, and processes by which corporate activity is directed
o Relationships between corporate managers, BOD, shareholders
o Relationship between corp., stakeholders, and society
Conflicting views about a corps purpose and responsibilities = shareholder versus stakeholder
o Should managers run based on the interest of shareholders or stakeholders?
o Anglo-American Approach:
Corporate governance is the system by which companies are directed and controlled.
Boards of directors are responsible for the governance of their companies. The
shareholders role in governance is to appoint the directors and the auditors and to satisfy
themselves that an appropriate governance structure is in place.2
o OECD Definition:
Corporate governance is the system by which business corporations are directed and
controlled. The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board,
managers, shareholders and other stakeholders, and spells out the rules and procedures
for making decisions on corporate affairs. By doing this, it also provides the structure
through which the company objectives are set, and the means of attaining those
objectives and monitoring performance.3
Shareholders, increasingly upset about outsized executive compensation deals and other governance
issues, argue that too many boards are beholden to management and neglect shareholder interests.
Purpose of the book: to provide a framework for analyzing todays corporate governance challenges. It
is written for executives who wish to prepare themselves to work with or serve on a board of directors
and seek to broaden their perspective from a focus on management to one on governance.
First section: Corporate Governance from a macro perspective
o Chapter 1: we describe the U.S. corporate governance system and its principal actors and briefly
survey the history of corporate governance in the United States, including the wave of
governance scandals that occurred around the turn of the century
o Chapter 2: delves deeper into the philosophical questions of ownership and accountability and
asks, Who owns the corporation? It contrasts the shareholder and stakeholder perspectives and
tries to find common ground between the two
o Chapter 3: focuses on the role of the board and provides an overview of recent trends in board
composition, structure, and leadership.
o Chapter 4: takes a close look at the flurry of reform adopted in the last 10 years. This analysis
shows just how much effective corporate governance depends on a delicate balance of power
among shareholders, directors, managers, and regulatorsand on properly aligned incentives,
clearly defined accountability and transparency, and last but not least, a steady ethical compass.
Second Section: takes a micro perspective and contains six chapterseach focused on major board
responsibilities:
o Chapter 5 discusses CEO selection and succession planning
o Chapter 6 takes up BODs responsibilities in the areas of oversight, compliance, and risk
management
o Chapter 7 BODs role in strategy development for the organization

o Chapter 8 deals with the issue of CEO performance appraisal and executive compensation
o Chapter 9 describes BODs challenges in dealing with the unexpected events and crises
o Chapter 10 analyzes BODs most difficult challenge managing itself
Last section: The last section consists of an epilogue and looks at the future and deals with subjects that are just
beginning to appear on corporate agendas. It analyzes the emerging global convergence of governance systems,
requirements, and practices; it looks at the prospects of further U.S. governance reform; and it discusses the
changing relationship between business and society and its likely impact in the boardroom.
Chapter 2: Governance and Accountability
2.1
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Main idea: do shareholders own the company?

o Debate 1: whether directors of a public company owe their primary fiduciary duty to its
shareholders (Bebchuk) or have to consider the prerogatives of all the stake holders (Lipton)
Bebchuk: shareholder-rights proponent
o the shareholder franchise is the ideological underpinning upon which the legitimacy of
directorial power rests
o corporate law gives boards the authority to hire and fire management and set the companys
overall directions
o fear of being replaced (directors) = increase accountability of directors and provide them
incentive to serve shareholder interest
o To make shareholder power real, he supports the proposal that directors be elected by a secret
ballot open to rival candidates nominated by shareholders.
Lipton:
o Argument: Corporations are the private property of stockholders shareholder do not own
corporation, only securities, etc.
o Directors, he argues, are not merely representatives of shareholders who have a legal
responsibility to put investor interests first. Instead, the role of the board is simply and dutifully
to seek what is best for the company itself, which means balancing the interests of shareholders
as well as other stakeholders, such as management and employees, creditors, regulators,
suppliers, and consumers
2.3

Shareholder capitalism vs Stakeholder Capitalism

o Defines the corporate mission: the corporation is seen as an institution with a continuing
purpose, and therefore, with a life of its own. Shareholders and wealth creation for owners do not
dictate its priorities. Rather, a deep concern for employees, suppliers, and customers, and
implicitly for its own continued existence, defines the corporate mission.
Opposed to Milton Friedmans The S.R. of business is to increase profits
Opposition to Friedman: Mackey believes that Friedmans view of business is too
narrow and underestimates the humanitarian potential of capitalism
2.3 the Primacy of Shareholder Interests Historical Perspective
- Ford vs Dodge
Purpose of business: organized for the profit of the stockholders = jo of directors
- Counterarguments: They noted that ownership of capital had become widely dispersed among many
small
shareholders, yet control was concentrated in the hands of just a few managers. Berle and Means warned that
the separation of ownership and control would destroy the very foundation of the existing economic order and
argued that managing on behalf of the shareholders was the sine qua non of managerial decision making
because shareholders were property owners.

again.
- If the corporation is an entity separate from its shareholders, it was argued, it has citizenship
responsibilities. [3]According to this point of view, rather than being an agent for shareholders, the role
of management is that of a trustee with citizenship responsibilities on behalf of all constituencies, even if
it means a reduction in shareholder value
- - US becomes committed to the principle of shareholder wealth maximization
2.5 Governance Without a Shared Purpose
- Main Idea: The lack of a clear, shared consensus about why a company exists, to whom directors are
accountable, and what criteria they should use to make decisionsin the law as well as in society at largeis a significant
obstacle to increasing the effectiveness of the corporate governance function.

Directors and their Accountabilities:

o Types: Each has a different vision of what modern corporations fundamental purpose is
Traditionalist
Rationalizers
Broad Constructionists

Chapter 3: The BOD: Role and Composition

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Responsibilities: Legal Framework

o Setting a corps policy and direction
o Electing and appointing officers and agents to act on behalf of the corp
o Acting on other major matters affecting the corp
Three categories of boards responsibilities (55)
o To make decisions
o To monitor corporate activity
o To advise management
3.2 A boards role: a governance perspective:
o Paramount Duty of BOD is to select the CEO and to oversee the CEO and senior management in
the competent and ethical operation of the corporation on day-to-day basis
o Second, it is the responsibility of management to operate the corporation in an effective and
ethical manner to produce value for shareholders. Senior management is expected to know how
the corporation earns its income and what risks the corporation is undertaking in the course of
carrying out its business. The CEO and board of directors should set a tone at the top
that establishes a culture of legal compliance and integrity. Management and directors should
never put personal interests ahead of or in conflict with the interests of the corporation
o Third, it is the responsibility of management, under the oversight of the audit committee and the
board, to produce financial statements that fairly present the financial condition and results of
operations of the corporation and to make the timely disclosures investors need to assess the
financial and business soundness and risks of the corporation
o Fourth, it is the responsibility of the board, through its audit committee, to engage an
independent accounting firm to audit the financial statements prepared by management, issue an
opinion that those statements are fairly stated in accordance with Generally Accepted Accounting
Principles and oversee the corporations relationship with the outside auditor
o Fifth, it is the responsibility of the board, through its corporate governance committee, to play a
leadership role in shaping the corporate governance of the corporation. The corporate governance
committee also should select and recommend to the board qualified director candidates for

election by the corporations shareholders

o Sixth, it is the responsibility of the board, through its compensation committee, to adopt and
oversee the implementation of compensation policies, establish goals for performancebasedcompensation, and determine the compensation of the CEO and senior management
o Seventh, it is the responsibility of the board to respond appropriately to
shareholders concerns
o Eighth, it is the responsibility of the corporation to deal with its employees, customers, suppliers
o and other constituencies in a fair and equitable manner. [1]
Most important decision a board must make: when must the board oversight become active intervention
Boards role depends on its nature (56)
3.3 The boards role: Governance, NOT management (60)
o Danger: Due to shareholder activism plus other social factors, the board are being pushed toward
micromanagement and meddling
o Key issues: how and to whom boards add value?
Not management, because it obscures the primary role of the BOD to govern, the
purpose of which is to add value to shareholders and other stakeholders (60)
o GOVERNANCE DEFINITION:
Governance is an extension of ownership, not of operations. Directors must be more
allied with shareholders than with managers. Their mentality, their language, their
concerns, their skills, their choice of interactions are subsets of ownership, not of
management. As long as we view governance as ubermanagementfocusing on
management methods, strategies and planning finding a new balance between
micromanagement and detachment will be hard to come by. (60)
o Tension between BOD and management: BOD wants greater independence while enhancing
executive accountability
o Effective governance is about striking a reasonable accommodation between verification and
trust not about elevating one over the other
3.4 Governance guideline
3.5 Recent board trends: board size, membership, director independence (64)
3.6 Board leadership: Should we separate the chairman and CEO positions? (67)
o Arguments:
Different people should hold each of these roles UK
Fours schools of thought
o 1. Separation of the chairman and CEO positions is a key component of
board independence because of the fundamental differences and potential
conflicts between these roles
CEO = runs the company
Chairman = runs the boards
Board = monitor the CEO
Separation = a check on the CEOs power
o 2. Nonexecutive chairman can serve as a valuable sounding board, mentor
and advocate to the CEO
relationships with the chairman based on mutual trust and regular
contact is good for the CEO, shareholders, and the company
Essential to avoid territorial disputes or misunderstandings
o 3. Non executive chairman is ideally placed to asses the CEOs
performance, taking into account the views of fellow BOD
help maintain a longer term perspective and reduce the risk the
CEO will focus too much on shorter term goals, especially when

there are powerful incentives and rewards to do

Good position to play a role in succession planning
Reduce trauma when CEo departs
o 4. Concerns the time needed to do both jobs and do them wells
When companies grow more complex, a strong board is more vital
to the health of the company, therefore, this requires as skilled
chairman who is not distracted by the daily pull of the business and
can devote the required time and energy
Summary: independence, boards function is to govern, not to manage

Combination US
Separation is bad because it might set up two power centers, which would impair
decision making (68)
Some may work in the UK, but not in the US
lead director approach
chairman with no commitment = problem with board effectiveness
separation of roles must be complemented by the right board culture and sound
process for selecting chairman
o 3.7 Board Committees and Director Compensation

Chapter 4: Recent U.S Governance Reforms

4.1 Recent Governance Reforms: An executive summary
- Reason for reforms: The
rationale for increasing director independence was that shareholders, by virtue of their inability to directly monitor management
behavior, rely on the board of directors to perform critical monitoring activities and that the boards monitoring
potential is reduced or perhaps eliminated when management itself effectively controls the actions of the board.
Additionally, outside directors may lack independence through various affiliations with the company and may be inclined to
support managements decisions in hopes of retaining their relationship with the firm. Requiring a
board to have a majority of independent directors, therefore, increases the quality of board oversight and lessens the
possibility of damaging conflicts of interest.
4.4 The Challenge: Striking a balance
Encouraging responsible, responsive governance rather than mere compliance should be the overriding goal and the principal
focus of reform. Truly effective boards understand their obligations to shareholders, other stakeholders, and
society at large. (87)
As noted earlier, changing the ethics of business behavior and the sociology of the
boardroom cannot be accomplished through structural changes alone. Instilling ethical behavior and
creating a value-creating orientation is fundamentally an internal process that can only be
successfully concluded with the complete support of both management and directors. It requires
openness to self-examination, a willingness to question individual and collective roles, a resolve to
address issues of process, and a receptivity to change.
Chapter 9: The Rise of Shareholder Activism
9.1
Not surprisingly, shareholder activism is controversial. Proponents argue that companies with active and

engaged shareholders are more likely to be successful in the long term than those that largely function on
their own. In their view, vigilant shareholders act as fire alarms, and their mere presence helps alleviate
managerial or boardroom complacency. Opponents say that shareholder activism is a form of
disruptive, uninformed, populist meddling that encourages short-term behavior and diverts a board from
a focus on value creation. Some particularly worry about the rise of hedge-fund activism. They note that
although hedge funds hold great promise as active shareholders, their intense involvement in corporate
governance and control also potentially raises a major problem, namely, that the interests of hedge funds
sometimes diverge from those of their fellow shareholders. These polar opposites reflect the broader
societal disagreement about how much power shareholders should delegate to corporate boards and when
direct shareholder action becomes necessary and on what terms.
9.2

Most of the pressure on boards in the last 25 years has come from shareholders. More recently,
however, a different source of pressurethe demand for corporate social responsibility (CSR)has
emerged, which is forcing directors into new governance territory occupied by stakeholders other
than shareholders. While pressure on corporate executives to pay greater attention to stakeholder
concerns and make CSR an integral part of corporate strategy has been mounting since the early
1990s, such pressure is only now beginning to filter through to the board.
The emergence of CSR as a more prominent item on a boards agenda reflects a shift in popular
opinion about the role of business in society and the convergence of environmental forces, such as
the following:
These trends indicate that there is both a growing perception that corporations must be more
accountable to society for their actions, and a growing willingness and capacity within society to
impose accountability on corporations. This has profound implications for the future of corporate
governance. It suggests that boards will soon have to deal with
a growing pressure to give stakeholders a role in corporate governance;
a growing pressure on corporations to disclose more and better information about their
management of social, environmental, and economic issues;
an increasing level of regulatory compulsion related to elements of corporate activity that are
currently regarded as voluntary forms of social responsibility;
a growing interest by the mainstream financial community in the link between shareholder value
and nonfinancial corporate performance.
The discussion about corporate accountability to stakeholders, therefore, while often couched in the
vocabulary of CSR, is really a discussion about the changing definition of corporate governance,
which is why it should receive a greater priority on the boards agenda.
Interestingly, whereas board agendas mostly focus on competition, cooperation may well become the
preferred business strategy for addressing social and environmental issues.
10.

10.1 Managing Itself: A Boards First Priority

A strong and effective board is clear about its role in relationship to management and understands
the difference between managing and governing. A boards principal duty is to provide oversight;
managements duty is to run the company. A good board also understands that it, not management,
has ultimate responsibility for directing the companys affairs as defined by law.
To meet these obligations, a board must take responsibility for its own agenda, or it will not be
independent. Management cannot be responsible for directors skills and processes and should not
have more than a consultative role in decisions, such as choosing new directors. Boards can no
longer be just advisers who wait for management to come to them. As fiduciaries, they must be
active monitors of management.
Two critical determinants of board effectiveness are the directors individual and
collective motivation and capabilities. The most effective boards score high on both dimensions; they

know and respect the difference between governance and management and appreciate where and
when they can add value. Conversely, boards that score low on both dimensions are likely to be
ineffective and function mainly as a statutory body. Capable boards with low levels of motivation
represent a missed opportunity, whereas highly motivated but less capable boards tend to meddle or
micromanage.
What makes for a good board? In Building High-Performance Boards, executive search consultants
Heidrick & Struggles observe that a high-performance board governs by continually challengingin
a positive wayevery significant aspect of the companys operations: its business model, strategies,
and underlying assumptions; its operating performance; and its leadership development. In doing
so, a best in-class board should seek to create a culture of rigorous, relentless examination, and press
for continuous improvement. This way it can set a tone at the top that reverberates throughout the
organizationto employees, to customers, to shareholders, and to the communities served by the
company.
Independent board leadership capable of shepherding the boards priorities and providing a voice for
the concerns of other outside directors is critical to board effectiveness. While not the only way to
establish such leadership, a nonexecutive chair can strengthen the independence of the board and
help create a healthy check-and-balance between management and the board. As an alternative,
some boards have adopted the so-called lead director model. If they do choose to appoint a
nonexecutive chair, boards should ensure that the individual selected for this position has the
experience, temperament, and commitment to the role to be effective. An effective chair serves as
the
leader of the board, keeps directors focused on the boards major priorities

10.4 Understanding the Sociology of the Board

A boards primary role is a fiduciary one. It is not surprising, therefore, that most board processes
are designed with this objective in mindto ensure management is accountable to the board and the
board to shareholders.
Consider, for example, the focus on greater disclosure, director independence, executive sessions,
increased communications with major shareholders, and on separating the offices of chairman and
CEO. All these changes are aimed at providing greater transparency and increased accountability.
They do not, however, address the deeper issue of how the board can function better as a group.
No group can operate effectively without a well-defined, shared understanding of its primary role
and accountability. The ongoing debate about the fundamental purpose and accountability of the
modern corporation has created a problem for boards as a whole, as well as for individual directors
what behaviorists call a heightened sense of role ambiguity and, in some instances, increased role
conflict.
The composition of the board should be tailored to the needs of the company. The board of an
acquisitive company, for example, should be well represented with deal-making expertise and
judgments, while the directors of a fast-moving technology company need a sound view of the
industrys future direction. However, every board needs to have certain essential ingredients, with
the individual directors possessing knowledge in core areas, such as accounting and finance,
technology, management, marketing, international operations, and industry knowledge. The best
directors enrich their board with the perspective of someone who has faced some of the same
problems that the company may face in the future. In addition, organizations in the early stages of
buildingor rebuildinga boardroom culture, often are best served by a knowledgeable, forceful
advocate for exemplary corporate governance. [1]
Behavioral characteristics are a major determinant of board effectiveness. Effective directors do not
hesitate to ask the hard questions, work well with others, understand the industry, provide valuable
input, are available when needed, are alert and inquisitive, have relevant business knowledge,
contribute to committee work, attend meetings regularly, speak out appropriately at board meetings,
prepare for meetings, and make meaningful contributions.

While there is no single, best approach to board evaluation, best practice suggests that an effective
board and director evaluation process is (a)controlled by the board itselfnot by management or
outside consultants; (b)confidential and collegialit should foster an atmosphere of candor and trust;
(c) led by a championalternatives include the non-CEO chairman, the lead independent director or
equivalent, or the chair of the nominating and governance committee; and (d) focused on identifying
areas of improvementin areas such as creating a balance of power between the board and
management, focusing the board more on long-term strategy, more effectively fulfilling the boards
oversight responsibilities, the adequacy of committee structures, and updating the evaluation
process itself.
A good process also evaluates individual director performancethrough self-assessment and peer
review. This should include consideration of independence, level of contribution, and attendance;
take specific board roles into account; and provide a basis for determining the suitability of a
directors reelection.